The Key Factors of Economic Integration in Southeast Asia: Case of Indonesia, Malaysia, and Thailand Kiki Verico University of Indonesia, Indonesia Abstract The major aim of economic integration in Southeast Asia is to shift economic integration from intra-regional trade to intra-regional investment before it achieves the common market. This article attempts to analyze the two essential factors in Southeast Asia’s economic integration: intra-regional trade and an economic community. In the first analysis, this article observes three selected countries: Indonesia, Malaysia, and Thailand; while in the second analysis it focuses on Indonesia as a case study. Findings from this article showed that free trade agreement is effective to increase intra-regional trade but not effective to attract investment; therefore suggesting that Southeast Asia needs to amplify its open-regionalism principle. This article also found that the private sector is ready for the economic community; therefore the ASEAN Economic Community (AEC) is fit for Southeast Asia’s economic integration exemplary. Key words: economic integration, international investment (long-term capital-FDI inflows), ASEAN Free Trade Area (AFTA), Bilateral Free Trade Agreements (BFTA), Asian noodle bowl phenomenon Introduction investment. Intra-regional trade is affected by its regional trade agreement known as The Association of Southeast Asian the ASEAN Free Trade Area (AFTA), Nations (ASEAN) is committed to while its impact is expected to attract transform Southeast Asia’s economic long-run investment inflows of Foreign integration in trade, which allows free Direct Investment (FDI). As intra-regional flows of goods to free flows of investment trade analysis is essential for Southeast and services. The latter is known as an Asia’s economic integration, this article economic community and has started attempts to observe both the impact of since the end of 2015. This agreement was free trade agreement to intra-regional implemented through the ASEAN trade and the impact of intra-regional 1 Economic Community (AEC). trade to FDI inflows. It is followed by a The key factor for this second observation on the economic transformation process is in its intra- community as this is the next stage to regional trade because it connects intra- intra-regional trade. regional trade and intra-regional Previous studies show that intra- regional trade is directly affected by the 1 For further detail, refer to implementation of AFTA through the http://www.aseansec.org/18757.htm. Journal of ASEAN Studies, Vol. 4, No. 2 (2016), pp. 107-126 DOI: 10.21512/jas.v4i2.887.g1736 ©2016 by CBDS Bina Nusantara University and Indonesian Association for International Relations ISSN 2338-1361 print / ISSN 2338-1353 electronic 108 The Key Factors of Economic Integration in Southeast Asia reduction of tariff barriers among its In addition, to analyze the impact members (Braga and Bannister, 1994; of AFTA on FDI inflows, this article Ravenhill, 1995; Menon, 1996; Bowles and adopts another type of agreements titled MacLean, 1996). A high intra-regional the direct Bilateral Free Trade Agreement trade indicates that the welfare-enhancing, (BFTA) as a factor to FDI inflows. BFTA trade-creating effects outweigh its directly connects ASEAN member states welfare-reducing, trade-diverting effects to non-member states. Some previous (Viner, 1950). An increasing intra-regional studies show that BFTA has been trade within members is expected to considered as a shortcut for member states attract long-run investment creation of to attract FDI inflows from non-member FDI inflows. states alongside regional trade agreements (Menon, 2006). BFTA is not prohibited in Theoretically, intra-regional trade ASEAN; therefore there is a potential risk affects FDI inflows in two ways: (1) an that BFTA can infringe the objectives of increase in horizontal FDI inflows from AFTA. In Asia, this glitch is known as the non-members which avoid trade ‘Asian noodle bowl phenomenon.’ impediments as a result of discrimination from regional trade policies (Markusen, In order to complete a model 1984), and (2) an increase in vertical FDI analysis of the factors and impacts of the inflows from members due to the Southeast Asia’s intra-regional trade, this increasing benefits from intra-regional article observes the economic community trade following the implementation of in Southeast Asia by finding the regional discriminative trade policies perceptions of firms, from both the (Helpman, 1984). manufacturing and service sectors, on the AEC. The analysis uses primary data Previous studies find that intra- based on a field survey of the upper- regional trade increases FDI inflows. middle level firms in Indonesia. The Applying Generalized Method of primary data is adopted from a survey Moments analysis to European Union titled ‘Monitoring of Investment Climate,’ (EU) member states in 1989-2001, Baltagi, of which one of its coverage in 2014 was Egger, and Pfaffermayr (2005) find that the firms’ perceptions on the AEC 2015. the increase of intra-regional trade This method is necessary to evaluate the significantly increased FDI inflows. perceptions of firms on the economic Dunning (1990) finds that the acceleration community, the next stage factor for of the United States’ FDI inflows in economic integration in Southeast Asia Europe, which occurred in the late 1950s, after the intra-regional trade. was affected by the EU’s discriminative trade policy towards non-member states. Objective Using fixed effects panel data of gravity model on 55 Organisation for Economic Based on the background, this Co-operation and Development (OECD) article attempts to conduct three analyses. countries in 1982-1997, Mac Dermott First, the factors that affect intra-regional (2006) finds that intra-trade integration trade. This is a proxy for trade creation encourages total FDI inflows in North effect. This objective is achieved by America (North American Free Trade adopting and testing two time dummy Area). variables: (1) the AFTA that is expected to create positive impact on Southeast Asia’s intra-regional trade and (2) the direct Journal of ASEAN Studies 109 BFTA that is expected to do the opposite: Model, Variable, Hypothesis, and create negative impact on ASEAN’s intra- Method regional trade. This article uses BFTA as a proxy to prove the existence of the ‘Asian Secondary Data Analysis: Case of noodle bowl’ in Southeast Asia. This Indonesia, Malaysia, and Thailand phenomenon is a major problem for This article chooses the time enhancing intra-regional trade in dummy of AFTA of year 19992 and, with Southeast Asia. the purpose of sterilizing from global Second, the impact of intra- economic crises in 2008, this article limits regional trade on FDI inflows as a proxy the time series up to year 2008. In order to of investment creation in Southeast Asia. have a balanced time series span, this This article adopts two dummy variables article selects the first time dummy of year of AFTA and BFTA as they are the factors 1988. Therefore, finally this article has 21 for intra-regional trade of trade creation years (1988-2008) of time series analysis. and intra-regional trade is a factor of FDI In order to make a connection inflows of investment creation. For these between the factors and impact of intra- two objectives, given several regional trade, this article has formulated considerations, the observed countries in two equations as a system. The first this article are limited to the ASEAN’s equation uses intra-regional trade as a founding members, in particular dependent variable while the second one Indonesia, Malaysia, and Thailand. uses FDI inflows. This article has adopted Third, the perceptions of firms on trade arrangements (AFTA and BFTA) as the AEC 2015 from both the the factors affecting intra-regional trade of manufacturing and service sector. These Southeast Asia that is complemented by perceptions are obtained from the field other macroeconomic variables as control survey conducted in the biggest ASEAN variables given that trade arrangements member state in terms of Gross Domestic are not the sole factor affecting intra- Product (GDP) and population size, regional trade. These trade agreements are Indonesia. The field survey had been treated as time dummy variables. The conducted in six big cities around time dummy for BFTA is its first time of Indonesia in 2014. In order to achieve this agreement among the observed countries, objective, this article designs questions which was 2004. (Indonesia signed its first that are related to the theory of economic BFTA in 2006, Malaysia in 2005, and community for respondents from upper- Thailand in 2004.) middle level classification. This article assumes that AFTA directly affects intra-regional trade and intra-regional trade directly affects FDI inflows.3 This assumption is also based on 2 According to Nesadurai (2003), the AFTA processes have three stages of negotiations: identification (1992-1995), expansion (1996- 1998), and implementation that began in 1999. 3 Indirect impact of AFTA to FDI inflows follows the preposition by Ravenhill (1995) and Bowles and MacLean (1996). 110 The Key Factors of Economic Integration in Southeast Asia the empirical facts that AFTA was in home of developed countries to invest.12 designed to boost Southeast Asia’s intra- Regarding that, this article uses nominal regional trade while, for attracting FDI exchange rate as local home currency per inflows, ASEAN offered ASEAN local host currency;